1. Technical Field
The present invention relates generally to an apparatus and process for automatically transacting an expirationless option for use in a variety of markets, such as commodities or securities markets.
2. Description of the Prior Art
An "option" is generally used to hedge risk by providing the right to purchase or sell a commodity or other asset at a later time at a set price with only limited obligations. An option is similar to an insurance policy in that it insures that an asset may be purchased or sold at a later time at a set price in return for a premium, often referred to as an option premium, which is generally a relatively small percentage of the current value of the asset. A first type of option, referred to as a "call" option in the securities market, gives the purchaser of the option the right, but not the obligation, to buy a particular asset at a later time at a guaranteed price, often referred to as the "exercise price." A second type of option, referred to as a "put" option in the securities market, gives the purchaser of the option the right, but not the obligation, to sell a particular asset at a later time at the exercise price. (The "put" option may be thought of as giving the owner the right to "put" the security into another's name at the exercise price.) In either instance, the seller of the call or put option is obligated to perform the associated transactions if the purchaser chooses to exercise its option.
For many years, options have been utilized in a variety of asset-based transactions. For example, in the commodities market, commodity producers (e.g., farmers) often enter into option relationships with commodity users (e.g., manufacturers) and speculators; in the real estate market, real estate owners often enter into option relationships with real estate purchasers; and in the securities market, security holders often enter into option relationships with security purchasers.
In an illustrative example for the commodities market, a commodity user (e.g., a cereal manufacturer) which expects that it will need a certain amount of particular commodities (e.g., corn and wheat) at a later time (e.g., in six months), may purchase a "call" option from a speculator. In return, the speculator receives the option premium in return for obligating itself to obtain and sell the set amount of corn and wheat at the exercise price six months from the time the option was granted.
Accordingly, if the price of these commodities increases over the six month period, then the cereal manufacturer will likely exercise the "call" option and obtain the set amount of commodities from the seller at the guaranteed exercise price. Therefore, by paying the option premium in advance of knowing the actual value of the commodities six months later, the cereal manufacturer may save itself a substantial amount of money, especially if the price of corn or wheat has substantially increased over the six month period due to a number of reasons (e.g., bad weather). Of course, if the price of these commodities does not reach the exercise price over the six month period, then the cereal manufacturer simply will not exercise its option and will purchase the commodities on the open market at the then going price.
On the other hand, farmers who plant their fields many months in advance of having a commodity ready for delivery and wish to guarantee themselves a set price for their commodity at a time in the future may purchase a "put" option from a speculator. Here, if the price (value) of the farmer's commodities goes down over the set period of time for a variety of reasons (e.g., exceptionally good crops among farmers), in return for the option premium, the farmer is guaranteed that it will receive a set amount of minimum income for his efforts from the speculator.
The most frequent use of options is in the securities market, where millions of options are typically transacted on a daily basis. In the securities market, investors may hedge the risk related to investing in securities associated with stocks in companies, bonds, commodities, real estate and many other assets.
Of importance, the common denominator among the variety of prior art systems for transacting asset-based options are that they are only capable of transacting options which expire after a certain period of "time". In other words, the purchaser of the call or put option using the prior art systems for handling option transactions only has the right to exercise its option before it expires or on the expiration date.
As shown in FIGS. 8-11, for a set period of time, an option transacted using a prior art system has some value associated with it depending on the type of option, the current value of the asset relative to the exercise price and other variables. However, the moment after the option expires, a purchased option, as shown in FIGS. 8 and 9, is worthless causing an option purchaser who may have owned a valuable option one day to own a worthless option the next day. Furthermore, not only is the option worthless, but the purchaser of the call or put option is no longer protected against future price fluctuations associated with the asset. On the other hand, as shown in FIGS. 10 and 11, a sold option, which might be falling in value, automatically rises to the value of the option premium and removes all future risks to the option seller the moment after the option expires.
Ignoring the effect of "time" and other nominal costs associated with transacting options, the value of the options (e.g., on shares of company A stocks) may increase or decrease based on the current price of the shares. For example, if the current share price rose from $50 to $54, then the value of the purchased call option (FIG. 8) would increase because it would be more likely to be exercised at the $55 per share exercise price. Further, if the current share price rose to $60, then the value of the purchased call option would increase even more because the owner of the purchased call option could now purchase Company A shares at the exercise price of $55 and sell them for $60 on the open market resulting in a $5 per share profit. Moreover, the value of the purchased call option would continue to increase if the current share price of the Company A shares continued to rise higher and higher. Accordingly, as long as the current price of the asset (the Company A shares) continues to increase, the profits associated with the return on investment for a purchaser of a call option are unlimited. However, as might be expected, the exact opposite results for the seller of the call option (see FIG. 10) in that the losses attributed to the seller of a call option are unlimited.
On the other hand, continuing to ignore the effect of "time," if the current share price dropped from $50 to $45, then the value of the purchased call option would decrease because it would be less likely to be exercised at the $55 per share exercise price. Moreover, as the current share price dropped further, the purchased call option would be even less likely to be exercised. However, unlike the situation above where the value of the purchased call option continued to increase as the current share price increased, for a purchased call option associated with an asset which decreases in value, the maximum loss associated with the return on investment is limited to the option premium (for this example, $5 per share). Again, the exact opposite results for the seller of the call option in that the profits realized by the seller of a call option are capped at the option premium.
Referring to FIGS. 9 and 11, similar yet opposite results may be realized by the purchaser and seller of a put option, respectively, using a prior art system for transacting options. Here, assume that investor P purchases a put option from investors who sells the put option on shares of Company A with an exercise price of $45 in six months in return for an option premium of $5 per share.
Here, again ignoring the effect of "time or other nominal costs," if the value of the Company A shares fell to $46, then the value of the purchased put option (FIG. 9) would increase because it would be more likely to be exercised. Moreover, if the value of the shares continued to fall to $40, then the value of the purchased put option would increase even more because the owner of the purchased put option would be able to obtain shares of Company A at a price of $40 per share and sell these same shares at $45 per share by exercising its put option resulting in a $5 per share profit. Accordingly, as long as the current price of the asset (the Company A shares) continue to decrease, the profits associated with the return on investment for a purchaser of a put option are limited to the exercise price (less the option premium paid) if the asset price fell to zero. However, the seller of the put option (See FIG. 12) realizes potential losses equal to the exercise price (less the option premium received) if the asset price fell to zero.
On the other hand, if the current share price increases, then the value of the purchased put option would decrease because it would be less likely to be exercised. However, regardless of how much the share price increased, the maximum loss associated with the return on investment that the purchaser of a put option would realize is limited to the option premium. In contrast, the seller of the put option realizes a maximum profit of the option premium.
Based on the above examples, it should be readily apparent that, ignoring "time," the purchaser of a call or a put option using a prior art system for transacting an option may essentially realize an unlimited gain while limiting his or her potential loss to the amount of the option premium. On the other hand, the seller of a call or a put option using the prior art system simply acts as an insurer for a period of "time" by collecting the option premium in return for insuring that the purchaser of the option will be able to buy or sell, respectively, the underlying asset at the exercise price for a certain period of "time."
However, the problem with such prior art systems is that "time" cannot be ignored. Specifically, such prior art systems limit the purchaser to purchasing call and put options only for preset increments of "time" which may or may not be a suitable amount of time to protect the purchaser and which leave the purchaser with a valueless asset after the preset increment of "time" expires.
Specifically, referring to the arrows pointed downward in FIGS. 8 and 9, even though a purchased call option may increase or a purchased put option may decrease in value as the current price of the asset increases or decreases, respectively, the value of the call or put option whose current price has yet to reach the exercise price must always battle "time." In other words, the closer that the call or put option gets to its expiration date, the more "time" will have a negative effect on the value of the purchased call or put option because "time" will be running out for the current price of the asset to reach the exercise price. Furthermore, if the current price of the asset on the expiration date is below the exercise price for the purchased call option or above the exercise price for the purchased put option, then, regardless of the current price, the option holder will (1) be left holding an option worth absolutely nothing and (2) be left unprotected in its efforts to buy or sell a particular asset at a later "time."
Therefore, a need exists for an apparatus and process for transacting an option which is not dependent on "time." In other words, a need exists for a system which transacts an expirationless option.
Of note, experts in the securities market and other markets dealing with options have concluded for many years that any system for transacting an option can only generate an option premium, which is fair to both the purchaser and seller of the option, if data representing the "time" in which the option expires is input into the system. More specifically, all algorithms that have been derived for generating fair option premiums include a variable for "time". Such algorithms include the Black-Sholes, Binomial Pricing and Analytic Approximation algorithms.
Moreover, not only is there a need for a system capable of transacting a fairly calculated premium for an option not dependent on "time," but there is a further need for such a system to automatically transact purchases and sales of expirationless options instantaneously while handling (1) the constantly changing current asset prices and other variables associated with the option premium pricing and (2) the high volume (millions) of daily options transacted in the securities market and other markets.
The above-referenced shortcomings, and other shortcoming of the prior art systems for transacting options that expire are effectively overcome by the present invention, as described in further detail below.